Nearshore vs Offshore

Current Trends in Global Sourcing

March 2005

Current Trends White Paper Series

Nearshore vs. Offshore SourcingRelative risks, rewards, and economic outcomes

SYNOPSIS: It is generally assumed that companies can save significantly more money by moving jobs off-shore to developing nations than they can by deploying to lower-cost domestic locations. In fact, whenall of the critical economic factors such as wage inflation, productivity, and management overhead areconsidered, many domestic locations sometimes offer savings that are comparable to, or even betterthan, offshore locations.

The trend of relocating non-core business functions offshore to developing nations suchas India and China continues to gain momentum. However, mixed among many wellpublicized successes are reports of unexpected costs, managerial strain, and culturalbarriers to effective operations from offshoring. This begs the question, "What deter-mines whether relocating offshore will meet with success or failure?" The answer liesless in program implementation and more in thoughtful due diligence about preciselywhich functions are suitable for moving offshore - particularly to a developing country.Commoditized functions that require more generic and easily acquired - and replaced- skills will continue to be strong candidates for offshore relocation. In contrast, morecomplex functions, especially those that employ industry-specific knowledge, informa-tion security risks, and/or discretionary decision making, will have markedly differentsavings and risks profiles, and therefore merit careful scrutiny before relocating to anoffshore site. For these functions, it is prudent to consider a nearshoring strategy, whichcan offer access to the requisite skills, and the mitigation of information risk and man-agement burden, while still providing savings that are comparable to - and possiblyeven better than - offshoring in the long-term.

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Deployment and Outsourcing: Two Paths to the Same Destination

Dramatic advances in informationtechnology during the last two decadeshave allowed organizations to separate corefrom non-core activities, thereby permit-ting firms to focus on the former in theservice of generating revenue and reducecosts associated with the latter. Two com-mon strategies for reducing costs related tonon-core functions are physically relocat-ing them (i.e., deployment) and farmingthem out to service-provider vendors (i.e.,outsourcing). Both deployment and out-sourcing are strategies that can be used tocapitalize on geo-variability in cost struc-ture by relocating functions to more cost-attractive locations; deployment does sodirectly by establishing captive centers insuch locations and outsourcing does soindirectly by contracting with service-providers that operate in such locations tomaximize their own margins. Deploymentand outsourcing can employ either an off-shore or nearshore strategy, based on thelocation to which functions are relocatedor the location of outsourcing service

providers. For example, offshore deploy-ment typically denotes relocating functionsto another continent (e.g., from the U.S. toAsia or Eastern Europe), whereas nearshoredeployment generally refers to an intra-continental relocation (e.g., from the U.S.to another U.S. location, Canada orMexico).

Initially, IT Services were the focus ofmost firms' offshore deployment and out-sourcing efforts. Such efforts were acceler-ated at the height of the internet boom,when the scarcity and expense of IT talentin the U.S. compelled firms to look abroadto support their businesses, as well as forspecial projects such as Y2K preparations.However, the scope of functions that havebeen deployed or outsourced offshore hascontinued to expand to Business ProcessOutsourcing (BPO)/IT Enabled Services(ITES), a broad category of functions thatinclude a great variety of support roles,ranging from answering customer queriesin a call center to sophisticated financialanalysis.1 Exhibit 1 lists some of the func-tions and activities that have been movedoffshore in recent years.


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Exhibit 1: Examples of Functions/Activities that have been Relocated to Offshore Sites

1 Although technically there is a distinction between BPO and ITES, as the former applies to all business support functions and the latter is specific to those that aremediated by technology, these two terms are often used interchangeably.

· Accounts Payable· Accounts Receivable· Animation· Applications Development· Call Center Activities· Cash Management· Check Processing· Collections· Complaints Handling· Credit Card Processing· Customer Queries· Data Processing & Management· Database Marketing & Management· Dealer Billing

· Digitization· Financial Analysis· Fixed Assets Accounting· Geographic Information Systems· HR Services· Insurance Claims Processing· Internal Accounting· Internet-based Help Desk· Investor Reporting· Invoice Processing· Loan Processing· Loan Servicing· Loyalty Program Administration· Medical Transcription Processing

· Mortgage Processing· Network Management & Maintenance· On-Line Education· On-Line Reservations· Payments Research· Payroll· Reconciliations· Revenue Accounting· Securities Research· Tax Preparation· Telemarketing· Telesales Support· Voice-based Help Desk· Website Services & Applications

Offshore Deployment andOutsourcing: Present andProjected Markets

There has been a veritable explosion inrelocating functions to offshore locations,whether through deployment or outsourc-ing arrangements. This trend has beenreflected macro-economically in the sec-toral redistribution of foreign trade in theU.S.; services imports have grown from14% to 17% of total imports between1980 and 2003 (Bureau of EconomicAnalysis, U.S. International TransactionsAccounts Data).

There is a wide range of projectionsabout the potential growth of the off-shoring services industry globally in thenear- and long-term. For example,McKinsey estimates that the BPO industryworld-wide was roughly $32 billion to $35billion in revenue in 2002, and projectedto grow at a rate of 30 to 40 percent peryear for the next five years (Agrawal,Farrell, and Remes, 2003). If these projec-tions are realized, the size of the globalBPO market will be well in excess of $100billion in annual revenue by 2008. Even

McKinsey's bullish outlook is conservativerelative to that of other organizations. Forexample, Deloitte Research predicts thatspending on off-shoring will grow to morethan $260 billion by 2010 (Gentle, 2004).It is likewise difficult to tally the number ofU.S. jobs that have moved overseas fromoffshore deployment and outsourcing ini-tiatives. Widely disseminated figures fromForrester Research hold that approximately830,000 jobs will have moved offshore byyear-end 2005, and that this total will growto 3.4 million by 2015 (McCarthy, 2004).

Offshore Destinations: Establishedand Emerging Host Locations

Since the dawn of offshoring as a costcutting and sourcing strategy, India hasbeen the location of choice for many of theUS and UK firms that have undertakensuch initiatives, largely because of its sup-ply of relatively inexpensive English-speak-ing workers. Recently, however, othercountries are emerging as competitors, as isillustrated in Exhibit 2.

To a certain extent India has become avictim of its own success, as explosive


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Exhibit 2: Schematic Map of Select IT and BPO Services Export Markets by Country of Origin

Source: neoIT, Inc.; Offshore Insights White Paper. Mapping Offshore Markets Update, June 2004.

growth in demand for IT and ITES/BPOservices has resulted in heated competitionfor talent and, consequently, steep rates ofwage inflation. Reports of insufficient sup-ply in IT and ITES skills abound, and inthe absence of a revolutionary re-tooling ofthe educational infrastructure, considerableshortfalls in these skills will follow. Forexample, a recent NASSCOM-KPMGstudy concluded that a shortfall in IT andITES/BPO skills of 500,000 workers isexpected by 2009 (NASSCOM Newsline,2004).

Other organizations agree. "Assuminga supply of 40,000 decent IT engineers ayear, McKinsey's Diana Farrell thinks thatIndia will 'not even come close' to meetingthe demand for one million offshore ITand software workers her company fore-casts for 2008" (A World of Work, TheEconomist, 2004). Not surprisingly, manyfirms - including major Indian serviceproviders - have recently turned to othercountries, principally in Asia, EasternEurope, but even the United States (forhigh-end skills) for more favorable labormarket conditions. For example, InfosysTechnologies, Tata Consultancy Services,and Wipro Technologies have all estab-lished applications development and main-tenance operations in China (Rai, 2004).

The Less Obvious Costs of MovingFunctions Offshore

Offshoring can be highly effective … insome situations, for some companies, andfor some functions. However, there aremany situations in which alternative solu-tions exist, solutions, moreover, that havelower risk profiles and operational com-plexity but still provide very significant sav-ings relative to the status quo.

It is all too easy to ignore the tremen-dous challenges and risks that accompanyoffshoring to a developing world venue:vast distances and time-zone differences,striking cultural issues, logistical chal-lenges, weaker intellectual property rightsprotection, regulatory requirements, lan-guage differences, complex and uncertainlegal and political environments, etc. Thesavings gained from deploying work to

economically developing countries do notcome without a price; there is a risk-rewardequation to consider. It is not unusual - insuch instances - for the savings gained froman offshore solution over-and-above thoseof a nearshore solution to be less com-pelling when this added risk and complex-ity are fully considered. Unfortunately,many offshoring decisions are made with-out considering alternative options - suchas nearshoring - that, because of less opera-tional complexity, risk, and disruptionmight ultimately be more attractive.

Furthermore, these offshoring decisionsare frequently made based on economicmodels that fail to incorporate the fullscope of variables that must be consideredto confirm both the immediate benefitsand those likely to accrue over time. Thisexposes one to the risk of vastly overstatingsavings levels, misrepresenting the sustain-ability of those savings, and ultimatelychoosing an option with a poor risk-rewardprofile. It is critical to instead evaluate off-shore deployment relative to alternativeoptions, and to do so in as comprehensivea manner as possible.

SSttaattiicc WWaaggee DDiiffffeerreennttiiaallssTime and again firms that approach us

for advice about offshoring start out withhighly unrealistic expectations of the sav-ings that can be achieved from such an ini-tiative. These expectations are usuallybased on either information of dubiousvalidity or vintage - typically from popu-lar media outlets - or from internal analy-ses that fail to focus on the segment of theoffshore labor pool that is actually requiredfor the functions being considered forthose markets. Forming an accurate,apples-to-apples comparison of currentstatic compensation levels is critical.

One approach that can overstate thesavings opportunity from offshore deploy-ment is assuming that the price for verygeneral skills within a specific functiongeneralizes to specialized skills within thatfunction. For example, the market pricefor a generic accountant with knowledge ofbasic FASB accounting practices will - notsurprisingly - show a wide spread between


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“Unfortunately, manyoffshoring decisionsare made withoutconsidering alter-nate options, suchas nearshoring...”


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U.S. and Philippine markets; this is thesort of spread that often makes its way intothe popular press and is used to justifydeploying functions to developing coun-tries. If one were to look for specializedskills within this function, such as fundaccounting on the low-end and accountingfor over-the-counter structured financialproducts on the high end, the spreaddiminishes (if it does not reverse outright).The reason for this is simply the supply-demand dynamics in developing countriesthat, by nature of having developingeconomies, do not produce comparablepools of talent - in quality and quantity - asdeveloped countries. This is not to say thatthe same specialized/esoteric skills areubiquitous in developed countries. Rather,they are simply more prevalent, and inthose locations where they are not availablein sufficient numbers the market canattract them (in contrast to the developingcountries, where a relocation from devel-oped countries is - to put it mildly - a hardsell). It must be emphasized that this isparticularly germane for highly specializedfunctions, such as complex analytics,

research and development, high-end pro-cessing, and sophisticated software devel-opment.

After rational estimates of an offshorecompensation cost structure are obtained,the next step is to understand what otherlocation alternatives exist, identifying therisks and operational nature of these alter-natives, as well as their respective coststructures. It is not unusual that, when allof the relevant decision-making factors areconsidered, nearshore options offer asourcing alternative that is ultimately a bet-ter operational fit than offshoring yet stillprovide very attractive economic benefits.These benefits, when loaded with both thesurface-level and less obvious costs ofstaffing, are often comparable to off-shoring, and can in fact be better.

Compensation differentials taken fromcurrent case studies, such as those shown inExhibit 3, can help clarify the differences inthe true costs of sourcing in select U.S. andIndian labor markets for high-end skills.The data in Exhibit 3 illustrate a compar-ison of annual per capita compensationcosts for a set of jobs currently residing inNew York and being considered for deploy-

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Exhibit 3: Baseline Wage Differentials: Average Annual Compensation for Applications Developers with 3 to 5 Years of Experience (2004)

ment to either a U.S. nearshore location orIndia. The New York baseline representsaverage compensation for a set of applica-tions development jobs being consideredfor deployment by a leading investmentbank. The nearshore baseline derives froma detailed examination of compensationlevels (involving multiple salary surveys aswell as detailed interviews with local "bluechip" employers-of-choice) in a major U.S.IT center in the Eastern Time Zone thathas abundant pools of the skills sought bythe New York-based firm, and the offshore(India) baseline represents actual payrolldata from top tier firms in Mumbaiemploying the exact same skills required bythis prospective employer. Clearly the sav-ings resulting from deployment to Indiaare highly attractive. On a per job basis,this firm would save 58% on compensa-tion (right now … more on the long-termprospects in the next section). But, thefirm could also save 30% by moving to analternate U.S. location, be within two-hours travel from headquarters in NewYork, operate entirely in the Eastern TimeZone, and more effectively manage theoperational risk associated with moving thefunctions by also moving key individualswith institutional knowledge to the newlocation (something it is virtually impossi-ble to do in any quantity when deployingoffshore to a developing nation).

It is critical for decision makers to askdifficult questions when considering aremote sourcing initiative. Do the addedsavings that result from going to the devel-oping world outweigh the advantages ofmoving to a nearshore location in the U.S.,albeit at a somewhat reduced savings rate?Have the economic analyses used to assesseach business case gone far enough?Specifically, have the relative costs associat-ed with each option been adequately com-pared? Without factoring in differentialrates of wage inflation, relative workforceproductivity rates, turnover, managementand administrative burdens, foreignexchange rates, and a host of other factors,the answer is a resounding "no".

Wage InflationSteep wage inflation is perhaps the most

obvious structural change that is affectingthe Indian off-shoring proposition.According to Hewitt Associates Inc.,salaries in India inflated by 14 percent in2003, whereas the increase in the U.S. was3.3 to 3.5 percent (Overby, 2004). "Hewittexpects Indian salaries to rise by another13% this year" (Fleming, 2004). Projectedlong-term demand for services in India -coupled with substantial shortfalls in sup-ply - suggest that wage inflation rates ofthis magnitude will be sustained if not ele-vated in the long-term. Thus, when assess-ing the true savings related to relocatingfunctions to India over the long-term, it isimperative to account for differential wageaccretion rates rather than simply assessingthe current spread in wage rates for specif-ic skills between Indian and domestic mar-kets.

Exhibit 4 illustrates the impact of dif-ferential wage inflation rates over time (thisexample is based on the same case shown inExhibit 3). The lines represent the differ-ence in savings achieved over time bydeploying from New York to a U.S.nearshore alternative relative to thoseachieved by deploying to India. Three dif-ferent lines are shown, each based on a dif-ferent "spread" in inflation rates betweenthe nearshore and offshore alternatives.

In all cases deploying in 2005 to thenearshore location results in approximately$22,000 (fully loaded) less in savings perjob than deploying to the offshore location.Of course, as shown previously in Exhibit3, it is important to keep in mind that thenearshore deployment is still saving over$21,000 per job relative to staying in thecurrent location. Savings are still substan-tial by deploying nearshore, but theemployer is not accruing an additional$22,000 in savings that could have beenachieved offshore. However, over time, asthe differential rates of inflation areapplied, the cost advantage of offshoredeployment shrinks and, in some cases,even eventually disappears. For example,the orange line represents an 11% spread ininflation rates between near-and offshoreoptions, reflecting the recent differentialsthat have existed between the two markets.


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“It is not unusualthat...nearshoreoptions offer a betteroperational fit thanoffshoring yet stillprovide very attrac-tive economic bene-fits.”

Over time the cost advantage of offshoredeployment steadily declines until, by2011, the per capita cost of offshore laboris actually higher than nearshore labor. Ifthe incremental inflation levels in an off-shore location are greater (as shown by thered line representing a 16% spread in linewith some of the forecasts that have beenmade recently) the rate at which the advan-tage decreases is accelerated.

Is it reasonable to assume that theseexact rates of inflation will continue?Ultimately, there is no way to really know.If a purely rational perspective were takenby current and potential market partici-pants, then the answer would likely be"no." As inflation continues in the near-term and wages continue to rise, employerswould - in an entirely economically ration-al world - temper the amount of employ-ment demand they channel into the Indianmarket. Lower demand, in turn, wouldserve to mitigate the continued upwardpressure on wages in the local market. Twocaveats related to these dynamics must bekept in mind. First, this level of rationali-ty is seldom applied presciently or proac-

tively ahead of a trend. Rather, macro-eco-nomic corrective behavior tends to occur asa response only when the "pendulum hasswung too far." Moreover, dramatic gainsin income levels - and resulting elevation inliving standards - create expectationsamong workers that lead to upward pres-sure on wages independent from labor sup-ply-demand dynamics or economic cycles(e.g., Japan post-WWII through the 1970sand China presently). Specifically, whenworkers transition from a subsistence-levelexistence to one in which some measure ofdisposable income is attained, the expecta-tion of continued (relative) prosperity soondevelops, and it is very difficult for workersto accept financial stagnation or regression.This, in and of itself, will not generateupward pressure on wages, however, asworkers become more sophisticated intheir understanding of employers' implicitreliance on maintaining their existingworkforce - even in the face of rising laborcosts - in order to avoid the greater cost anddisruption involved in even a phaseddecommissioning and deployment to anew venue, there is both considerable


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Note: Accretion spread based on India accretion levels of 10%, 15% and 20% vs. Nearshore at 4%

Exhibit 4: Per Capita Cost-Savings of Nearshore (U.S.) Deployment vs. Offshore (India) Deployment with Varying Wage Accretion Spreads: Applications Developer with 3 to 5Years Experience

motivation and recognized ability forworkers to demand greater compensation.

The bottom line is that the analysesshown in Figure 4 frame the "bet" that anentrant to this market is making. Therewill be a trend towards significant wageinflation. The exact rate over the long-term, while unknowable, is dependent onthe behavior of other market participantsand the trajectory of virtually inevitablemacro-level societal trends; both factorscompletely beyond any individual marketparticipant's control. Therefore, one mustbe resigned to the fact that the marginaleconomic benefit of India relative to anear-shore location will contract over time,and the rate and degree to which it willcontract is likely to be significant but fun-damentally unpredictable and beyond anindividual employer's control. The key isto assess the likely trend, the resulting long-term relative economics of the variousoptions, and assess whether an offshoreoption truly provides enough incrementalsavings to outweigh the advantages inher-ent in a nearshore option.

Worker Productivity LevelsDifferential rates of worker productivi-

ty between domestic and offshore marketswill also impact the savings pro forma. Ifworker productivity in an off-shore loca-tion is lower than that of domestic produc-tivity then more resources will be needed inthe former, which will obviously have adeleterious impact on the savings gainedfrom moving functions offshore.Comparatively lower productivity in off-shore markets can have several causes, fromcultural differences that negatively affectthe efficacy of call center staff to lessertraining and/or experience for more highlyskilled positions. An example of the lattercomes from the case of Bladelogic, aWaltham, Massachusetts-based softwarefirm that decided to repatriate work sent toIndia because it "could be done faster andat a lower cost in the United States"(Porter, 2004). This counterintuitivenotion that IT Services sourced in the U.S.can in fact be cheaper than those sourcedin India demonstrates the magnitude of the

economic impact that differential produc-tivity levels can have.

The effect of differential rates of pro-ductivity between offshore and nearshoreIT labor markets is illustrated in Exhibit 5(based on the same case study described inExhibits 3 and 4). The curves show theimpact that differing relative productivitylevels have on the economic outcomesrelated to offshore and nearshore deploy-ment, both immediately (prior to anyimpact from wage accretion) and at twolater points in time as the wage inflationtrends discussed in the previous sectioncome into play (in this case, the analysesassume an 11% wage inflation differen-tial).

As shown in Exhibit 4, in 2005 (shownas the green line in Exhibit 5) deploying toIndia results in an added $22,000 (fullyloaded) per job in savings over-and-abovewhat can be achieved by deploying to thenearshore U.S. location. However, thisassumes that the same productivity levelcan be achieved in India as can be achievedin the U.S. (Point A on the graph). Anyproductivity deficit in India will result in adecrease to these incremental savings. Forexample, if productivity in India were onlyto reach 80% of that in the U.S., the addi-tional savings in 2005 would shrink to justover $10,000 per job (Point B). If produc-tivity were to shrink to 65%, then essen-tially we have reached a point at which thetwo scenarios - U.S. vs. Indian deployment- are cost neutral (Point C). There are noadded savings generated by deploying toIndia instead of deploying to a nearshoreU.S. location. Anything short of 65% rel-ative productivity in India will result in theIndian deployment program being less eco-nomically beneficial than a U.S. nearshorealternative program.

The 2005 line shows the current state,with no added impact from differentialrates of inflation. When current wageinflation differentials (i.e., 11%) betweenIndia and the U.S. nearshore market arecarried forward in this analysis, the pro-ductivity bar is raised. By 2008, produc-tivity in India must be at approximately82.5% of that achieved in the U.S. in order


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for the two options to be cost neutral(Point D). At any productivity level belowthat, greater economic savings are achievedin the U.S. By 2012, were current infla-tionary trends to continue, productivity inIndia must exceed productivity in the U.S.by approximately 12% in order for the twooptions to be cost neutral (Point E).

In the context of reports of comparativeproductivity between U.S. and Indianworkers performing increasingly complexfunctions, these are aggressive productivitygoals merely to break even. What produc-tivity level is likely when staffing functionsin a developing country that is distant fromthe primary businesses it supports? Thisultimately must be addressed on a case-by-case basis. However, extensive discussionswith those who have implemented suchstrategies have been informative. It isexceedingly rare to find organizations thathave experienced rates of productivity evenapproximately comparable to that of thelocation from which the jobs weredeployed - even after very significant peri-ods of extensive training and then years ofsustained operations in the new locale. At

the extreme end, some organizations haveachieved productivity levels as high as 65%of that of the origination point. In mostcases, estimates range from 35% to 50%productivity relative to the originationpoint. In contrast to these experienceswith offshoring, it is rare to find employerswho have deployed to carefully chosennearshore locations that have not achievedproductivity levels equivalent to that of theorigination point.

TurnoverAnother cost associated with competi-

tion for human resources is related to staffturnover. The costs of employee turnoverrelate to recurring productivity losses andthe attendant costs of filling vacated posi-tions (e.g., recruiting, screening and train-ing). In India, "… the competition hasbecome so fierce that typical Indian opera-tions in business processing … can expectto lose 15 to 20 percent of their workforceseach year. … In some sectors of the out-sourcing market, attrition rates are 50 to75 percent a year, according to SunilMehta, Vice President of the National


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Exhibit 5: Per Capita Cost-Savings of Offshore (India) Deployment vs. Nearshore (U.S.) Deployment as a Function of Varying Productivity Levels: Applications Developer with 3to 5 Years Experience, Wage Accretion Differential 11%

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Association of Software and ServicesCompanies, or NASSCOM, an industrytrade group in India" (Scheiber, 2004).When offshoring involves largely routine,commoditized tasks with minimal traininginvested in each worker, turnover has littlereal economic or operational impact. Thetime required to replace the workers thathave left is minimal - as is the cost of train-ing their replacements - and the time ittakes replacements to reach full perform-ance/productivity levels is short. As thefunctions being staffed offshore becomemore complex - and the skill requirementsof workers and the time necessary to trainthem become greater - turnover is nolonger a minor consideration.

Management/Administrative OverheadAn additional disparity between off-

shore and nearshore deployment that mustbe accounted for in order to achieve a com-prehensive economic pro forma is relatedto management overhead.

It is often assumed that the manage-ment structure at the origination point willnot change and that little added manage-ment/administrative overhead will berequired in the new offshore location. Atypical expectation is that the new offshorelocation will require an on-site, typicallyadministrative, site manager along with avery small number of additional adminis-trative staff. Further, the line managementremaining in the original location willoversee and manage the actual functionsand processes performed in the new loca-tion remotely, often from many time-zonesaway. This may be true for simpler, com-moditized functions, but is simply not thecase for complex and/or specialized func-tions.

Factors such as extensive time zone dif-ferences between deployed functions andthe groups they support at the originationpoint (both front- and back-office), exces-sive travel time, and substantial culturaldifferences impose a heavier managementburden on the firm. For example, if afunctional team that requires team mem-bers to routinely make discretionary deci-sions at the origination point is disbanded

so that half of the roles can be deployed toa distant location, it is likely that addition-al line management resources will berequired for oversight at the deploymentlocation. Even assuming equivalent pro-ductivity between the origination pointand the deployment location, additionalresources will have to be acquired to man-age the deployed sub-unit on-site, resultingin a net add of (managerial) resources fromdeployment. If the same deploymentoccurred at a nearshore location, to whichmanagers could travel quickly and sponta-neously, the requisite number of additionalmanagement resources from deploymentwill be lower and quite possibly - depend-ing on the function and the near-shorelocation - no additional resources will berequired.

Additional economic disparitiesbetween offshore and nearshore deploy-ment exist, such as travel, real estate, con-struction, utility, and telecommunicationcosts, foreign exchange rates etc. In short,one must look beyond surface level com-pensation differentials as a measure of thepotential savings opportunity afforded by adeployment initiative; it is imperative thatone look at the less obvious incrementalcosts, and from a dynamic and long-termperspective.

SummaryIt is important to understand the socie-

tal and macro-economic trends that makean offshore location attractive for sourcingwork, as these trends can provide insightinto whether the qualities that make thelocation attractive are sustainable over thelong-term.

India serves as a relevant examplebecause of its position as the dominant off-shore services market. The boom in off-shore services that India has enjoyed is dueto its inexpensive English-speaking work-force. The low cost of Indian labor relativeto that of the economically developedcountries of the West is due to the fact thatthe Indian economy is still in the process ofrising from third world status and that itssupply of human capital is vast (over 1 bil-lion). What has to be kept in mind is thatthe true size of the employable workforce


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proximity requirements may not be a sim-ple task when evaluating functions that arepresently proximate to other func-tions with which they interact. A simpleheuristic for doing so is to determine theimportance of prompt face-to-face interac-tions in a crisis situation. Some tasks arebasic enough that system failure can beremediated via telecommunications, or oflow enough business value that remedia-tion can be put off long enough to accom-modate extensive travel. In contrast, thereare countless other functions that,although they are not core activities, are ofsufficient complexity and business valuethat they require on-site and timely reme-diation in order to avoid substantial rev-enue or client loss.

A related factor is the extent to which afunction being considered for deploymentis sensitive to time zone differences. At therisk of again stating the obvious, the morethat this is the case, the less suited a func-tion is for offshore deployment. Whereasthis may be obvious, the consequences ofmoving certain functions to distant timezones may not be. For example, businessprocesses that are considered for deploy-ment to a distant offshore location whichmust work synchronously with functionsthat are not candidates for deploymentmay require shift work at the offshore site.Although not a scarcity in offshore loca-tions, shift work does lead to higherturnover than standard working hours, andone should factor in additional costs andbusiness continuity issues that are a conse-quence of additional turnover (especiallywhen turnover during standard businesshours is high, as is presently true in India).Organizations can tolerate turnover, in facta certain amount of turnover is beneficialbecause new staff bring new approaches toproblem solving, but every organizationcan tolerate only so much.

There are certainly other factors thatcan render offshore deployment inappro-priate for an organization, perhaps themost widely reported being the impact ofcultural differences in communicationswith offshore staff or between offshore staff

and the customers that they serve. Theseare too numerous to discuss in detail here,but taken together these factors, which willdirectly affect business operations in anorganization's deployment facility, can be -indeed, often are - as salient in the decisionmaking about deploying functions offshoreas cost reduction. Reducing costs from off-shoring will have to be re-evaluated if theeffort to do so inadvertently reduces rev-enue, especially with the specter of a costlyreturn of functions looming in back-ground. Although deploying functionsoffshore will certainly continue - perhapsnot at the super sonic rate predicted bysome - as the paroxysm to do so continuesto subside, organizations are coming torealize that deploying functions to offshorelocations is not the best strategy for alldeployable functions. Rather, evaluationshould be done on a function-by-functionbasis, and in the case of functions thatshould not or can not be deployed off-shore, there are viable nearshore optionsthat offer compelling - if not comparableand even more attractive - savings rates.


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“Reducing costs fromoffshoring will haveto be re-evaluated ifthe effort to do soinadvertantly reducesrevenue, especiallywith the specter of acostly return of func-tions looming in thebackground.”

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tion strategy for corporate America.However, the savings opportunity will varydepending on the complexity, industry-specific specialization, and risk profile ofthe functions that are considered for mov-ing offshore, particularly in the case ofdeployment to captive centers rather thanoutsourcing. The least complex functionswill have a fairly straightforward savingsprofile, one that is reflective of more gener-ic skills that are relatively easy to acquire(and replace) and manage over a large geo-graphic distance. The savings profile formore complicated functions will have amarkedly different profile and in somecases less savings than that offered bynearshore deployment opportunities. Forthese strata of functions, a surface levelcomparison of compensation differentialsbetween the baseline (i.e., the originationpoint) and potential offshore andnearshore locations will be misleading.

It is also critical to realize that offshoreand nearshore strategies are not mutuallyexclusive. For many companies - especial-ly large, complex corporations with a widerange of functions and processes - one par-ticularly attractive approach involves a mixof both strategies. A number of our clientshave implemented solutions in which rou-tine, highly structured functions with lowrisk profiles were deployed to an offshorelocation (either captive or outsourced)while high value-add, complex, mission-critical functions and processes weredeployed to a nearshore location. The off-shore component provides a sourcing plat-form providing maximum sustainable sav-ings when the correct functions are chan-neled there. At the same time, thenearshore component ensures significantsavings (often only marginally less dramat-ic than if those functions were moved off-shore) that can be sustained long-term,proximity to headquarters, time-zone con-sistency or proximity, little/no added riskrelative to the status quo environment, anda more suitable labor pool.

Beyond the Buck: Other Factors toWeigh in the Consideration ofDeployment

The actual savings from offshoring cer-

tain functions may be enough to causereflection about whether this sourcingstrategy should be implemented, but thereare other factors that also have to beweighed in this decision. Again, thisassessment must be done on a function-by-function basis. In some industries, such asFinancial Services, there may well be regu-latory issues that have to be considered forspecific functions. Such issues are notalways explicit, rather they require dialoguewith regulators. For example, after theSeptember 11th attacks in New York, agroup of federal agencies that included theFederal Reserve and the SEC put togethera series of white papers that strongly rec-ommended enhancement of business con-tinuity/disaster recovery plans to ensure theliquidity of the capital markets in the eventof another cataclysmic event. Although nomandates have been issued, the federal gov-ernment continues to take a keen interestin this matter and, while geographic sepa-ration of securities execution and transac-tion processing functions is encouraged,plans to relocate the latter offshore wouldlikely inspire strong reactions because ofthe introduction of additional operationaland geopolitical risks.

Another factor worthy of considerationinvolves information security. Maintainingnetwork security and protecting intellectu-al property are major concerns in the devel-oping world. A widely known example ofthe latter is the theft of source code anddesign documents reported by JollyTechnologies in its recently opened R&Dfacility in India (Ribeiro, 2004). Althoughsuch a crime is by no means unique toIndia, and India has established adequateintellectual property laws, enforcement ofthose laws has proven to be challenging.Perhaps even more distressing are the risksattendant with moving functions thatrequire access to high value client informa-tion, such as institutional securities tradingactivities.

Although painfully obvious, it is worthmentioning that organizations must thinklong and hard about the proximity require-ments of functions that they are consider-ing deploying. Objectively understanding


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“It is also critical torealize that offshoreand nearshorestrategies are notmutually exclusive.For many companies...one particularlyattractive approachinvolves a mix ofboth strategies.”

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in IT and ITES/BPO services is but a frac-tion of the total workforce because India'seducational infrastructure is not universal-ly available. In fact, India continues tohave third world illiteracy rates (32% ofadult males, 55% of adult females) and theaverage number of years of education inIndia is a little more than five (WorldBank, 2002). This accounts for why therecent increase in demand for IT andITES/BPO skills in India has strained theIndian labor markets despite the size of thetotal population. As noted above, thestrong growth in demand for IT Servicesand ITES/BPO skills in India has resultedin heated competition for those skills, andconsequent sharply increasing wage infla-tion (e.g., 13% - 14%) and employeeturnover (15% - 20%) rates. This pattern isnot unique to India. As other developingnations have undergone similar changes inthe past, similar dynamics arose, and it isnot unreasonable to expect that otheremerging market economies will do thesame.

As a developed-nation nearshore pointof comparison, Canada, which has a frac-tion of India's population but a world-classeducational infrastructure, has benefitedfrom stable (i.e., similar to the U.S.) wageinflation and turnover rates, despite havinga BPO export market that is greater thanIndia's ($5 billion vs. $3.1 billion; neoIT,2004). Similar to Canada, historic andprojected wage inflation and employeeturnover rates in a host of viable nearshoremarkets in the U.S. are dramatically lowerthan those of India, and must be reflectedin a comparative analysis of the long-termeconomic impact of Indian offshore andnearshore deployment. To summarize, ifthese wage escalation trends in India con-tinue at anything even approximating cur-rent rates, the savings opportunity willshrink significantly. It is even possible that,on a productivity-adjusted basis, over themedium-term India's labor costs mayexceed those of some alternative markets indeveloped countries.

The objective of deployment and out-sourcing initiatives is first and foremost toreduce costs, and doing so via an offshorestrategy can optimize savings. However, asdescribed above, there are numerous hid-

den costs associated with offshore sourcingof work. When these costs are fully fac-tored into a long-term economic view, thesavings profile of offshore sourcing relativeto nearshore sourcing can change - depend-ing upon the functions considered fordeployment - markedly. The savings ratesfrom offshore deployment that are oftenbandied about are as high as 70 to 80%,based on current compensation differen-tials between domestic and offshore labormarkets. However, these differentials usu-ally derive from the lowest level skill sets,and make no provisions for the manifesta-tions of different labor market dynamicsdiscussed above, such as differential wageinflation, turnover, and productivity rates.Achievable savings from outsourcing toIndia, for example, are typically less thanhalf of the compensation differential(Scheiber, 2004). Thus, even if the muchballyhooed compensation differentials of70% to 80% are taken as a given (andassumed to be static), the true savings ratefrom offshoring would net 35% to 40%.This savings rate is substantial, but wouldonly hold if comparable productivity rateswere realized. In reality, differential pro-ductivity would further reduce the savingsrate, well below 30% for some functions.It is important to note here that, relative tobusiness capitals in North America andEurope such as New York, San Francisco,and London, savings rates in excess of 30%are achievable by implementing anearshore sourcing strategy. (In such cases,the benefits of proximity, minimal - veryoften no - time zone differences, ease oftravel, and cultural homogeneity are add-ons to the savings proposition). This viewis echoed by Tom Weakland ofDiamondCluster, who noted recently inBusiness Week, "A Russian programmercharges 80% less than an American. Butwhen you parse it all out, the total cost ofoffshoring a given IT job is generally com-parable to getting the work done domesti-cally" (Kharif, 2003).

None of this is to say that moving func-tions offshore cannot work. The size anddramatic growth of offshore services indus-tries testify to their import as a cost reduc-


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“When these [hidden]costs are fully fac-tored into a long-term economic view,the savings profilerelative to nearshoresourcing canchange...markedly.”

BibliographyAgrawal, V., Farrell, D., and Remes, J. K. (2003). Offshoring and Beyond:Cheap Labor is the Beginning, not the End. The McKinsey Quarterly 2003 SpecialEdition: Global Directions.

A World of Work: A Survey of Outsourcing (2004). The Place to Be: In theGlobal Market for White-Collar Work, India Rules Supreme. But Others are LiningUp. The Economist, November 13, 2004.

Bureau of Economic Analysis, U.S. International Transactions Accounts Data,Table 1 (http://www.bea.gov/bea/international/bp_web).

Fleming, E. C. (2004). Is the Passage to India Still Worth it? Barron's Online,May 4, 2004.

Gentle, C. (2004). The Titans Take Hold: How Offshoring has Changed theCompetitive Dynamic for Global Financial Services Institutions. Deloitte ResearchReport.

Kharif, O. (2003). The Hidden Costs of IT Outsourcing. Business Week on Line,October 27, 2003.

McCarthy, J.C. (2004). Near-Term Growth of Offshoring Accelerating: Resizing USService Jobs Going Offshore. Forrester Research IT View and Business View Trends,May 14, 2004.

NASSCOM Newsline (2004). Narrowing the Manpower Divide. NASSCOMNewsline, Issue 29.

neoIT (2004). Research Summary: Mapping Offshore Markets Update 2004.Offshore Insights White Paper, June 2004, Vol. 2, Issue 6.

Overby, S. (2004). Trendlines. India Sees IT Wages Rise. CIO Magazine,February 1, 2004.

Porter, E. (2004). Send Jobs to India? U.S. Companies Say It's Not Always Best.New York Times, April 28, 2004.

Rai, S. (2004). India Taps China's Reserve of Technological Talent. New YorkTimes, November 2, 2004.

Ribeiro, J. (2004). Source Code Stolen through Yahoo E-Mail: The Twin Perils ofLarge Free Storage and India's IP Laws. IDG News Service, August 5, 2004.

Scheiber, N. (2004). As a Center for Outsourcing, India Could Be Losing Its Edge.New York Times, May 9, 2004.

World Bank (2002). World Development Indicators.


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